How do I achieve £15,000 Isa income?

RICHARD MCBRIDE'S PORTFOLIO

Source: Investors Chronicle, as at 17 September 2014.

Chris Dillow, Investors Chronicle's economist, says:

The good news here is that you are probably on course to meet your objective of an income of £15,000-£18,000 in seven years' time.

If we assume an annual return on your portfolio of 4 per cent per year after inflation, then this portfolio should grow to around £340,000 (in today's prices) in seven years' time. If annuity rates don't change - which is a cautious assumption given that markets expect gilt yields to rise - this will give you an annual income of just under £18,000.

Naturally, though, there are risks around this: I reckon there's around a one-in-six chance of you ending up with an income below £12,000.

As you can imagine, I applaud your decision to shift out of funds into ETFs. Remember that fund fees compound nastily over time. This means you need a very good reason to buy them - and in most cases, these reasons don't exist.

You say you're concerned that you're over-diversified. I'm not sure you are.

Only around a third of this portfolio is not in equities: your corporate bonds and silver. And corporate bonds have an equity-type component to them. In bad times, credit risk rises which causes corporate bonds - especially those of riskier companies - to fall at the same time that share prices fall. In this sense, you are putting all your eggs into one basket.

Granted, your equity holdings are well-diversified across countries and market segments. But there's a problem here. Pretty much all equities - and especially baskets of equities - are correlated to some extent with the global market. If this takes a tumble, therefore, you'll lose.

I fear this might be especially true of your emerging markets holdings. These face two especial dangers right now - that they will be hurt by the slowdown in China's economy and that they are not yet fully discounting the impact of a likely rise in US interest rates next year.

Yes, there is a case for emerging markets exposure - partly on the grounds that their long-term returns should compensate you for their extra riskiness and partly because they protect us from risks to western stock markets such as the possibility of long-term slow growth. But I would warn against big exposure to them.

From this perspective, you are right to wonder whether you should become more conservative. There is, though, an obvious problem here; any shift to less risky assets would entail a big loss of expected returns, given that real returns on cash and high-quality bonds are so low, and likely to remain so.

There's nothing you can do about this, as it's a brute fact about the investment environment. What I'd advise is that you think about how well-placed you are to take on equity risk. Given that you are on course to exceed your income target, you could afford to scale back risk, sacrificing some returns for more security.

Could you get by on an income of less than £15,000? Could you tolerate working longer? If the answers to these questions are yes, then big equity exposure is possible. If not, you need to reduce the riskiness of this portfolio. The easiest way to do this is simply to hold cash.

By contrast, there's one thing you say you're worrying about that I wouldn't bother with - inflation.

Granted, this would probably be bad for equities if it happened, because there has traditionally been a positive correlation between inflation and dividend yields, implying that higher inflation means lower equity valuations. But given that the eurozone is seeing super-low inflation now, and that inflation isn't terribly responsive to economic activity, the danger of higher inflation seems low right now.

Certainly, this could change if, say, sterling falls a lot or if commodity prices soar. But you can protect yourself from this - if you must - by holding either commodity ETFs or foreign currency. Again, though, doing so entails a big loss of expected returns. I suspect you should have higher priorities - the main one being whether your split between equities and safer assets is correct.

David Liddell, the founder and director of online investment advisory service IpsoFacto Investor, says:

This is a diversified portfolio that has been put together with a lot of thought. You have recognised that, with only 10 per cent in cash and fixed interest and an underlying exposure to the UK of around 30 per cent, it may be appropriate to move the portfolio in a 'conservative' direction as you approach retirement.

The current underlying yield on the portfolio is 2.2 per cent (an income of £5,500), so you will need to make significant changes to increase the income towards the £15,000 level you require in seven years' time. Even if the dividends from the portfolio grew by 5 per cent a year compounded (2.5 per cent is more realistic), this might at best turn into a yield of 3.7 per cent (on current value) or around £9,000 in seven years, assuming dividends are reinvested. Unfortunately, with yields on cash and fixed interest so low, there may be a conflict between the need to increase income and moving in a conservative direction.

Our general approach would be to make gradual adjustments to the portfolio in the direction of higher yielding and/or more conservative holdings, reducing specific risk; for example, swap your two individual European equities for JPMorgan European Income IT (JETI), yielding 4 per cent and on a discount of 10 per cent. If anything the portfolio is underweight the UK, so we would move some of the fund holdings and non-yielding assets into UK income investment trusts such as Temple Bar (TMPL) and Edinburgh (EDIN); these trusts have large accumulated revenue reserves, so they should be able to increase dividends at least in line with inflation.You may want to add to existing commodity exposure through BlackRock World Mining (BRWM), where the resources sector could be due for a recovery (although we would sell the silver ETF).

You should consider increasing the fixed interest exposure over time, mindful that interest rates may rise (and long-term gilt prices probably fall); we are not keen currently on corporate bonds or index-linked gilts (real yields are negative) so we would favour conventional gilts, where longer-dated issues (eg, Treasury 4.25 per cent 32) might be suitable to reinvest the coupon and then take the income when there are 10 years to run until maturity. As an alternative to gilts, you might use some of the equity and bond investment trusts, such as Investors Capital Units (ICTU) or M&G High Income Packaged Unit (MGHP), although these clearly carry equity risk.

Other than the funds, holdings from which you might consider raising cash initially include RIT Capital Partners (RCP) and British Empire Securities & General (BTEM). Perhaps add to the UK mid-cap exposure, through Schroder UK Mid Cap (SCP) and JPMorgan Mid Cap (JMF); in due course you may wish to swap your individual UK equities for such holdings.

In terms of your planned activity, as regards financials, there is the Polar Capital Global Financial Trust (PCFT), although it has 52 per cent in banks. You might like to consider investing directly in fund managers instead, for example Ashmore (ASHM) and Schroders (SDRC). North American Income Trust (NAIT) or the new iShares MSCI USA Dividend IQ UCITS ETF (HDIQ) can provide higher-yielding US exposure; equally, in terms of the fund switches (as well as the UK trusts mentioned above), look at JPMorgan Emerging Markets Income (JEMI) and Aberdeen Asian Income (AAIF). We reiterate that it may be hard to achieve the desired income; a gradual approach to switching into some of these higher-yielding and/or more conservative holdings will help move in the right direction.